Recently, a friend was venting to me about his real estate woes. The problem? The latest uptick in the housing market got him thinking about selling his house.
He checked to see what houses in his area were selling for, took a look at some online estimates and even got the house appraised. Confident he knew what his place was worth, he put it on the market. But when the final sale price came in, it was less than what he had been expecting. As he complained to me, “What’s the point of an appraisal if that’s not the price you really get?”
Anyone who’s ever participated in a real estate transaction is familiar with this dynamic. Appraisals and other price estimates can give you an idea of what a property is worth, but when push comes to shove it’s the buyers and sellers who determine price. And, at the end of the day, price is all that really matters. My friend can complain until he is blue in the face about the injustice of it all, but it’s not going to change anything.
As we like to say on the trading desk, a trade is an agreement on price, but fundamentally a disagreement on value between buyers and sellers – otherwise, a transaction would not occur. Incidentally, this same scenario exists in the bond market. For example, lately there’s been much ado about volatile markets causing bond ETFs to trade at a discount to their underlying portfolios, or net asset values (NAVs). And it’s easy to understand why this may cause some anxiety. After all, if you sell your bond ETF at a discount to NAV, you’re going to get less than what the fund’s aggregate underlying bonds are “worth” – right? [Bond ETFs and Illiquid Markets]
I put ”worth” in quotations not to be flippant, but to draw a parallel to the real estate example – namely, that a bond ETF’s NAV is similar to a housing appraisal: A helpful guide? Absolutely. Completely accurate? Usually not. Here’s why: